Precautions before investing in South African green energy

South Africa and China signed a series of agreements during the August 2023 visit by President Xi Jinping on co-operation in renewable energy projects, opening a wealth of investment opportunities for Chinese businesses. The agreements were an indication of Beijing’s commitment to supporting the green transition of South Africa’s power generation and transmission infrastructure.

Renewable programme

To ease the power crisis and fulfil commitments to reduce emissions and become carbon-neutral by 2050, South Africa has issued a raft of renewable energy policies, including the Renewable Independent Power Producer Programme. The programme aims to promote private investment in renewable energy from foreign and local sources through an open bidding process.

South African state-owned power company Eskom will enter into a power purchase agreement with the winning bidder to take its energy output in full at the agreed feed-in tariff within 20 years from its commencement of commercial operations. The South African government will provide a guarantee. Since the implementation of the programme in 2011, six rounds of bidding have been completed with contracts awarded to Chinese bidders.

Participation model

As bidding continues in more and more rounds, many agencies specialising in the pre-development of renewable projects have emerged in South Africa. After securing projects, completing site selection and establishing the project company, the agency will approach investors looking for renewables projects in South Africa and enter into equity transfer agreements with the investor.

As this model is well established in South Africa, which is a sellers’ market, usually the seller provides a well developed equity transfer agreement template, leaving little room for the buyer to negotiate and make modifications. The transaction is generally divided into an equity delivery stage and a co-operative development stage.

As the project companies are mostly newly established entities and are not subject to governmental restrictions on equity transfers in South Africa, the equity delivery period is often short (e.g. the delivery can be completed within 14 days after signing the equity transfer agreement).

Unlike with renewables projects in China, the South African government does not prohibit acts such as illegal transfer of project approvals, so no approval from the competent authority is required for an equity transfer before the project is put into production.

Most of the conditions precedent to delivery are very simple. In addition to internal authorisation on both sides, generally only the buyer’s satisfaction with due diligence results is required, which involves the credit standing of the agency, valid incorporation and existence of the project company and any pledge of its equities. Buyers often pay a relatively low equity transfer price at this stage.

After the equity transfer, the co-operation development stage begins. Generally, according to the agreement, the seller is fully responsible for handling all preliminary formalities and obtaining relevant permits or licences, with the buyer paying service fees that correspond to each formal step.

This stage is further divided into two phases: ready to bid and post-bidding. The former is crucial, as the project company’s ability to complete the approval procedures required by the tender documents directly affects its ability to participate in bidding. For example, in the sixth round of bidding, bidders are required to complete the environmental impact assessment and obtain approval documents prior to bidding.

Some precautions

Due diligence should begin as early as possible. Given the fierce competition in South Africa’s renewable energy market, the time from engagement with agencies to signing equity transfer agreements is often short.

Gaining early access to the seller’s database for due diligence will significantly affect the depth and thoroughness of the investigation.

Chinese companies, especially state-owned enterprises, are often required to navigate complex internal approval processes and make decisions based on the results of due diligence. Conducting due diligence early allows sufficient time for these approval procedures. Otherwise, the deal may fail, resulting in the regret of missed opportunities.

Project development formalities and licences. According to the deal arrangement, the seller is responsible for going through preliminary formalities and securing permits or licences for the project that involve a lion’s share of the transaction price. Chinese investors should carefully sort out the formalities, permits and licences required for the project based on local laws and regulations, and the requirements of the programme bidding documents, and include a detailed list of stage-specific formalities, permits and licences in the equity transfer agreement to avoid disputes between the parties over the completeness of related work during the deal implementation.

Localisation requirements. For foreign investors in South Africa, the Broad-based Black Economic Empowerment (B-BBEE) is a policy deserving extra attention. In a narrow sense, this policy can be regarded as a localisation requirement of the South African government. Although the South African government does not impose any equity restrictions on foreign investment in the renewables sector, the bidder’s responses to the B-BBEE during the programme bidding process directly impact scoring and bidding results.

For example, in the sixth round of bidding, bidders are required to ensure a minimum local shareholding in project companies and contractors. Before bidding for projects under the programme, Chinese investors should study the scoring criteria under the B-BBEE and consider how to incorporate the South African component, such as partnering with local companies, in their investment or bidding strategies.

Exit mechanism. The unsuccessful bidder will miss the opportunity to enter into a power purchase agreement with Eskom, resulting in no revenue from the project and rendering the investment purposeless.

Given the significant uncertainty in bidding, Chinese investors should consider an exit mechanism at the beginning of the investment, such as including buyback clauses in the equity transfer agreement or holding the seller liable to pay damages for a failed bid. Alternatively, investors may consider holding onto the project in the event the bid fails and waiting for the next window for another attempt.

Wang Jihong is a senior counsel and Chen Dingduo is an associate at Zhong Lun Law Firm